Speculator vs. investor

At the root, the market provides us with the ability to be owners of the world’s greatest businesses without building or managing them ourselves. When we invest, we place belief in the idea that combining money, good ideas and motivated people will produce a sum greater than its parts.

As investment counselors investing on behalf of our clients, we have criteria for the type of businesses to own long-term. Portfolios focus on businesses with a healthy mix of assets and liabilities on the balance sheet as well as management teams capable of implementing a resilient strategy that exploits a competitive advantage.

They also focus on businesses where the purchase price is fair, given long-term growth expectations for cash flow earnings and dividends. When combined, we can have the reasonable expectation of sizeable wealth creation with time. This is the elegantly simple idea behind “investing”. It is the long-term ownership of businesses. Over time, good businesses produce a fairly reliable and predictable return on the investment capital they employ.

In contrast, speculating differs greatly from investing. Many participants in bond and stock markets don’t think about the underlying businesses they are buying into. Instead, they see changing prices and trading momentum. They attempt to predict short-term market direction to time their entry and exit in order to seize a profit from moving paper—repeated until rich or ruined.

Long-term cash flow, earnings and dividends aren’t given much weight in the trading decision, as the investment holding period is short. Of more interest to the speculator is the potential for the “price multiple” to change quickly in their favour if investors are willing to pay a higher price for the same dollar of business cash flow or earnings.

This type of trading—much of it powered by computer algorithms and overconfidence—causes bond and stock prices to swing wider in the short-term than otherwise justified by changes in the company’s business or in general investor sentiment. In practice, the day-to-day volatility grabs the majority of the media’s focus and captures those in the investing public that choose to follow market noise.

From the perspective of a long-term investor, the level of speculation in investment markets is enormous, and can dramatically influence prices in the short-term. For well-diversified investors with appropriate asset allocation and suitable fees, there is little reason to fear these price movements. Simply put, they seldom destroy a strong underlying business model.

Where they do create angst is for investors without a sound plan and without a timely source of ethical investment counsel to guide decision making. Although there may be times when the balance of market probabilities justifies tilting the portfolio in favour of one asset class, those opportunities are much less frequent than generally believed.

Keep these thoughts in mind the next time you hear someone talk about a great “investment idea”. Does it truly fit in the investment category or is it mere speculation? If doubt remains in your mind, consider whether the underlying reason to own the bond or stock creates true wealth or whether it relies on a “greater fool” purchasing the investment from you in the future.

This article was first published in Navigate, an ATB Investor Services publication that provides valuable insights for wealthy and institutional investors. To read the full issue, click here.